General Motors Corp.'s borrowing costs rose to the highest in almost two years after the world's largest carmaker lost financial support from General Electric Co.
The extra yield, or spread, investors demand to hold the automaker's euro-denominated debt due 2033 widened 40 basis points, or 0.40 percentage point, to 578 basis points, the most since the securities were sold in June 2003, as of 11:28 a.m. in London, according to Royal Bank of Canada prices.
GM, the world's third-largest corporate borrower with $114.5 billion of bonds, on March 16 forecast its biggest quarterly loss since 1992, prompting Standard & Poor's to say it may lower the automaker's credit rating to below investment grade. GE, the world's No. 2 company by market value, yesterday cut short an agreement giving the carmaker's suppliers faster payment.
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This situation has started to effect other corporate borrowers.
The spread between Treasuries and investment-grade corporate bonds widened by 5 basis points, from 79 -- its narrowest gulf since 1998, according to the wire service, citing Merrill Lynch -- to 84. Junk bonds fared even worse, as their yield spreads widened an average of 25 basis points, to 298.
As a result of the bond market sell-off, reported Bloomberg, one company that could see its borrowing costs rise immediately is DirecTV, which plans to sell $500 million of notes this week. The company is rated several notches below investment grade, depending upon the rating agency. Morgan Stanley has $11.5 billion of debt maturing this year, and it is poised to pay a higher coupon when it refinances this debt. (The bank's own analysts believe that the reaction to GM's plight is wildly overdone, notes Ron Fink, moderator of the CFO Blog.)
What's more, GM's bad news caused several companies to delay bond offerings, said James Probert of Bank of America Corp. according to Bloomberg. "We had a handful of people who decided they wanted to see a better environment, he told the wire service, adding that things might turn around as soon as next week.
Still, the environment is not exactly gloomy for potential borrowers. Bloomberg pointed out that the average yield on A-rated debt at the end of last week was 5.62 percent, well below the average of 6.83 percent over the past five years, according to Moody's data.
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The GM situation could gradually deteriorate until they are forced to declare bankruptcy -- which is not the end of the company, but definitely not good news. Currently GM has a 9.4 billion interest expense on its income statement. GM also has to go to the market on a regular basis because of their finance arm. As their interest costs increase it is possible their margins (essentially the difference between their revenue and expenses) will continue to get squeezed. Their operating margin is currently .62%. (Ford has a 2.8% operating margin and and Chrysler has a 2.8 operating margin).
Here is why this story is important.
1.) GM employs about 324,000 poeple. If there is a problem with the company, you can bet that layoffs will happen quickly.
2.) There are numerous other companies that depend on GM -- especially parts makers that sell directly to GM. If GM slows down, there will be a ripple effect to suppliers
3.) GM stated that health costs were a prime reason for their problems. Ford and Chrysler are in the same boat. And yet, Congress is doing nothing. Toyota has a 9.7% operatinig margin.
4.) Autos and airlines are the last old generation corporations still in existance. Neither are doing well. Most US airlines are either in bankruptcy or operating at a major loss. Ford and Chrysler are in better shape, but not much.
5.) SUVs are the most porfitable vehicles the automakers sell. I doubt that an increase in oil prices will encourage sales for these vehicles. In other words, as oil prices increase, it is possible (but certainly not guaranteed0 that we'll see Ford and Chrysler making similar announcements.
[update]Jerome posted an excellent diary that deals highlights the effect of credit rating agencies (Moody's, Fitch and S&P) on the bond markets and GM in particular.LINK